Wednesday, September 16, 2009

Measured in dollars, Brazil's stock market has rebounded 164% since its lows of last November. I've highlighted this chart several times in the past, remarking that the outlook for emerging market debt and equity was very promising. So far that advice has been spot on. One key to the emerging market economies' recovery is easy money. Easy money helps push commodity prices higher, and it helps weaken the dollar. Both of these result in a big rise in cash flows for these economies. Another factor is that they suffered terribly in the crash last year, so their rebound should be stronger. Yet another, which is relatively unremarked, is that for the most part these economies enjoyed better monetary policy than the U.S. did in the years leading up to the crash. Most emerging market currencies appreciated significantly relative to the dollar because of better monetary policy. Without the easy money-goosed speculation in real estate markets, their economies weren't so damaged in the crash. They suffered mostly from a big drop in commodity prices, but that problem has faded fairly rapidly with the return of easy money. Finally, I would say that one reason these economies had better monetary policy was because they have managed (with some exceptions, notably Argentina) to mature at the fiscal policy level. Policies have been generally more stable and more respectful of the power of free markets than they have been in the past. When you introduce stability and maturity to an economy that has struggled for years only to keep falling behind the progress in the industrialized world, you have the potential for some spectacular growth catch-up, and that is what we are seeing now.

Full disclosure: I am long EMD, CHN, and SLAFX at the time of this writing.

I'm struggling. TBT has way underperformed relative to what it claimed it would do. It suffers from the negative carry implicit in any short bond position, but it still has underperformed my expectations. Nevertheless, I can't bring myself to sell a position that looks like a big winner. It is all a question of timing, though. If it takes another year for the bond market to wake up, then TBT will bleed money. I need bond yields to start rising soon.

I have real trouble understanding how the bond market can continue to ignore rising gold, rising commodities, a falling dollar, a recovering economy, a massively easy Fed, and a Treasury that needs to sell gazillions of bonds for as far as the eye can see.. That adds up to the perfect inflation/interest rate storm, yet bond yields are only 3.5%. Good grief.

Of course, in the meantime I am doing very well with AAPL and most of my other equity positions. I am well ahead of the market this year. So I am not all that upset.

I've been a fan of TBT for most of this year, and I'm running out of patience. An aggressively short bond position, which TBT represents, is only going to work if something happens in a relatively short time frame. This is a dynamic which the Fed is exploiting: by continuing to promise that short rate will stay at zero for a very long time, they are also promising that short bond positions will be very costly. That forces people to abandon short bond positions, and that is one thing that helps keep bond yields relatively low. So to like TBT you have to believe that the Fed is going to have to change its tune in a relatively short time frame. I don't think that my ability to time things like this is better than that of the market, so I'm not willing to take a big position in TBT at this time. If I'm wrong and the Fed moves to tighten sooner than the market expects, then my long equity positions and long TIPS positions will most likely be doing well.